Mining the Tax-Free Exchange

01/06/2011

Each year taxpayers spend billions of their hard-earned dollars on federal taxes. One way to defer taxes is to engage in a like-kind exchange under Section 1031 of the Internal Revenue Code. These exchanges allow taxpayers to defer taxation and have more of those dollars to spend today.

A like-kind exchange (commonly referred to as a Section 1031 exchange) is particularly beneficial for oil, gas or other mineral properties. As long as investors properly plan ahead to satisfy the requirements of a like-kind-exchange transaction, managing an exchange is not difficult. Here’s how investors can determine whether to enter into a like-kind exchange, the necessary steps, and potential tax traps to avoid.

Generally, when you sell, exchange or otherwise dispose of property, you pay tax on any gain resulting from the transfer. The like-kind exchange is an exception to this general rule. It allows you to exchange property held for productive use in a trade or business or held for investment purposes for other business or investment property without paying federal income tax on that property.

The unreported gain is not recognized for federal income tax purposes and is not subject to tax until the property received in the exchange is ultimately disposed of in a taxable transaction. Through a properly structured like-kind exchange, the payment of tax can be deferred for many years, and potentially forever.

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